manufacturing « Citizen Economists

Manufacturing Sector Growth Hits 29 Months in a Row

By Eldon Mast, on November 2nd, 2011

Manufacturing continues to be the shining star in this recovery. Several reports out this week underscore the fact that US factories continue to post solid results in a growing US economy.

The ISM report on business reported on Tuesday that their “PMI indicates growth for the 29th consecutive month in the overall economy, as well as expansion in the manufacturing sector for the 27th consecutive month. The past relationship between the PMI and the overall economy indicates that the average PMI for January through October (55.7 percent) corresponds to a 4.6 percent increase in real gross domestic product. In addition, if the PMI for October (50.8 percent) is annualized, it corresponds to a 2.9 percent increase in real GDP annually.”

On Monday two region reports underscored the ISM report.

Very strong rates of monthly expansion in the Chicago area extended through October. The Chicago purchasing managers composite index came in at 58.4, well above 50 to indicate monthly expansion in general business activity though at a slightly less robust pace than September’s 60.4 level. But October’s 58.4 reading, which is four tenths above the Econoday consensus, is impressive and is right at the four-month average of 58.5.

In Texas — factory activity increased in October said the Dallas Fed Manufacturing survey. The production index remained positive, suggesting growth is continuing. Other measures of the Dallas survye of current manufacturing conditions also indicated growth in October, and the pace of new orders accelerated, compared to September.

The reports summarize surveys which include businesses from all areas of the economy — surveys that continue to show exceptionally healthy manufacturing conditions in their regions.

Decline Denial Duquesne

By Christopher Briem, on October 24th, 2011

In the 1980’s it was Homestead that staked out the emotional heart of the Rust Belt miasma. Outside of Detroit in recent years Braddock has cornered the PR market for as Jim R. would put it: “Rust Belt Porn”. Yet then and now the city of Duquesne has declined as much and suffered as much, just with much less notice.

So now the news comes with the outcome both inconceivable and inevitable that the state is likely to shut down the Duquesne school system completely. The city’s school district has already abdicated secondary education with its high school students shipped to nearby West Mifflin or East Allegheny. This is all more epilogue than news sadly. Still feels like a story from the worse off parts of the third world. In security studies if you anonymized the name it would in part be indisinguishable from case studies in failed states and feral cities.

But that news story highlights again how little we understand our own problems.. how myth overtakes reality. The section and quotes that caught my attention was the almost de rigueur logic on the impact of the steel industry. It goes by formula exactly like this:

Chepanoske points not to any person or government entity but to the loss of jobs and subsequent sharp population decline.

Census figures show Duquesne was home to 11,410 people in the 1970s when steel mills provided good-paying jobs. Today 5,565 people live there.

“When the mills were running full blast, things were really good,” Chepanoske said. “It started to deteriorate in the 1980s when people moved away.”

In other words.. it’s nobody’s fault. Steel left. Blame ’steel’. Whatever that means. That seminal year 1970 is the only horizon that matters it seems.

Did the decline of manufacturing cause Duquesne’s decline? Did it accelerate the population decline even? When was the last time things were really ‘good’ in Duquesne? Here is the city’s population over the century. Can you identify any meaningful break in trend in the 1980s? But if the problems are caused by the loss of steel jobs, and the decline in steel jobs are somehow beyond our control, then ergo.. this just isn’t anyone’s fault.

Is Duquesne’s plight unconnected to manufacturing? Of course not. But the heyday of Duquesne came long ago at this point. The workers in the mills along the rivers started abandoning those towns long before there was any conception steel was ever going away. The first hand memories people have of a growing or even stable Duquesne can only be among those receiving Social Security. If we misunderstand our problems we can’t ever fix them and attributing the plight of many of the barely existing.

I have not even gotten into the joke that Duquesne with barely 5K population in 2010 is still a ‘City’ according to the laws of Pennsylvania. Upper Darby Township in Delaware County, PA clocked in at over 82K residents in 2010. Makes sense somehow. Goes back to what the real problems are in Pennsylvania. Saddest part of the Duquesne story is that they just didn’t have any large bond payments to default upon. If only they had been so irresponsinle as to build a garbage incinerator, the Commonwealth apparachiki might have paid some real heed.

If you want to obsess on on the stylized Duquesne history, don’t recereate the wheel. Just jump over to DuquesneHunky. It would do the neighboring Tube City Almanac proud. I actually can’t believe it’s author is not Jason’s alter ego.

The more things change - energy edition

By Christopher Briem, on October 10th, 2011

Some have asked whether I agree with the story earlier in the week on the size of the energy industry in the region. I have not read it in detail, but without getting into any specific numbers sure I do. Energy has long been a huge part of the regional economy. One can argue energy is what we really always were good at. Without the coal, there would have been no steel and so forth and so on. But it goes far beyond that if you connect the dots as I wrote years ago in Energy Burgh.

The funny thing is that when I wrote that I really had folks Downtown laugh at me. It was the past was the message, not the future. For much a decade, other than some interest in ‘clean coal’, energy was not a focus of development. It was all talk of ‘high tech’ (pick your definition), biotech in particular, ‘advanced’ manufacturing (I’m not sure there is anything other than ‘advanced’ manufacturing still surviving these days) and until the bankruptcies of USAirways, air transportation. Remember when air transportation was going to ‘replace steel’ which was as stilly a concept then as it is now. Talk of energy was ‘quaint’ as literally put to me. That general apathy was the main reason I felt compelled to write that piece.

The irony is that if you go back and look at the date of the oped.. 2005. That must have been awfully close to the time some meeting somewhere was going on starting with “you know, we can get natural gas out of the shale in Pennsylvania”. Funny how disruptive things work. Just wait until the ‘greater’ Pittsburgh geothermal industry kicks in which will likely all center on fracking as well and found with Google’s help. Nothing happens on it’s own. It’s all interconnected.

One thing I mentioned in that article which didn’t plan out was the whole fuel cell project that did not pan out. At the time it was the biggest thing on the horizon. The fuel cells Siemens was working on were to be powered by natural gas for the most part. Even in failure, the fuel cell story is a lot more important than it may ever seem. Pittsburgh beat out intense competition for the fuel cell investment from locations in Florida, but more intense competition from Ross Perot who was pushing for the site to go to Texas and clearly put more money on the table at the time. Yet sheer money didn’t win in that decision which says a lot. In the end the market could not quite support what they were trying to do and they could not quite get their manufacturing costs low enough to make the product, mostly intermediate sized stationary fuel cells, viable. In some counterfactual world, if the decline in natural gas prices had come a bit earlier, maybe we could have added a growing fuel cell industry to the region as well. Think what the regional ‘energy story’ would have been. Alas.

The site that was to be the fuel cell manufacuting operation? Taken over by US Steel for research. Again, the more things change……

So is the local energy industry all or even mostly shale gas. Clearly no. Is the increase in jobs or output reported in the story all shale related. Probably not either. Check out the story on the gubenatorial election in WV decided this week. In it is this quote:

But the rising price of coal has boosted the state’s economy, giving it a lower unemployment rate than the nation at large and allowing Mr. Tomblin to boast of a state budget surplus in contrast to the fiscal straits of some of its neighbors.

So when you really push out beyond the MSA, and certainly into the 32 counties some focus on these days, coal is still the presence defining the economy, especially when you are talking sheer number of jobs.

Free Trade Fallacies

By Simon Grey, on August 29th, 2011

I sympathize with the sentiment, but this is a dumb way to analyze free trade:

Decades of outsourcing manufacturing have left U.S. industry without the means to invent the next generation of high-tech products that are key to rebuilding its economy, as noted by Gary Pisano and Willy Shih in a classic article, “Restoring American Competitiveness” (Harvard Business Review, July-August 2009)

The U.S. has lost or is on the verge of losing its ability to develop and manufacture a slew of high-tech products. Amazon’s Kindle 2 couldn’t be made in the U.S., even if Amazon wanted to.

First, how can Gary Pisano and Willy Shih be sure of the keys to the future? The eight-track used to be the way to the future of music; the laserdisc used to be the future of home movies (as did HD-DVDs). How can anyone say with any degree of certainty that high tech products are the key to the future, especially in light of diminishing marginal returns? The simple fact of the matter is that there is no way to predict what people in the future want, and there is no need, then, for this sort of histrionics.

Second, who says manufacturing is the key to future wealth? What makes Apple products so popular isn’t their manufacturing specs; it’s how they’re marketed. It may be that marketing is key to the future, especially if consumers become considerably more concerned with status. As such, focusing on America’s ability (itself a logical fallacy) to manufacture certain products is shortsighted and unnecessary.

Finally, why is the ability to manufacture high-tech products considered a hallmark of American competiveness instead of domestic economic policy? If one truly wants to understand why American manufacturing has declined, one need look no further than the federal government’s domestic economic policy. It has become increasingly anti-business and anti-manufacturing over the past decades, and more supportive of foreign trade. As I have demonstrated many times now, this combination is eventually going to prove fatal to American businesses.

Thus, the problem isn’t that “America can’t manufacture a Kindle,” it’s that American businesses are being increasingly hamstrung by the American government. The solution, then, is to repeal the economically destructive laws put in place by the government; it is not lamenting over the decline of high-tech manufacturing.

Pop Quiz

By Simon Grey, on August 25th, 2011

Q: Who said this:

Second, the idea that U.S. economic difficulties hinge crucially on our failures in international economic competition somewhat paradoxically makes those difficulties seem easier to solve. The productivity of the average American worker is determined by a complex array of factors, most of them unreachable by any likely government policy. So if you accept the reality that our “competitive” problem is really a domestic productivity problem pure and simple, you are unlikely to be optimistic about any dramatic turnaround. But if you can convince yourself that the problem is really one of failures in international competition—that imports are pushing workers out of high-wage jobs, or subsidized foreign competition is driving the United States out of the high value-added sectors—then the answers to economic malaise may seem to you to involve simple things like subsidizing high technology and being tough on Japan. [Emphasis added.]

A: Paul Krugman (Pop Internationalism p. 16 [1996], The MIT Press, Cambridge).

In spite of his remarkable daily stupidity, Krugman actually correctly recognizes the problem of American competitiveness in international trade. What hampers America is not foreign trade, but domestic productivity. And one of the biggest hindrances to domestic productivity is government, both at the state and municipal level, and particularly at the federal level. Thus, if one wants to know why Americans are losing manufacturing jobs, one need only look at domestic policy. The federal government has increasingly hamstrung manufacturing jobs over the past several decades.

Furthermore, instead of allowing consumers to feel the pain that domestic production policy would naturally incur, the federal government instead decided to promote increased foreign trade (under, it should be noted, the auspices of so-called “free” trade). This policy has then had the effect of subsidizing foreign production at the expense of domestic production because foreign manufacturers do not have to face the massive regulatory costs that domestic manufacturers face, giving foreign manufacturers a leg up on their competition.

As I have undoubtedly noted before, there are only two correct positions for a domestic government that presumably claims to represent the people over which it governs. Either the government can highly regulate domestic business and place tariffs on imports that approximate the costs faced by domestic producers or the government can reduce the burden of regulation on domestic business in conjunction with the decreased cost of importing. It is, however, quite foolish to do what the U.S. government is doing now: highly regulate domestic business while decreasing the cost of importing. Either a high degree of regulation is desirable or it is not. If it is, whatever regulations that exist should be applied to every person and corporation that wishes to do business in America. If it is not, the domestic market should be deregulated posthaste. There is no excuse for the current state of affairs.

Manufacturing Mythos

By Christopher Briem, on June 22nd, 2011

So the President is coming to Pittsburgh on Friday to talk about manufacturing. We may be at the point now where people forget how much manufacturing was lost here. At the beginning of the 1970’s the region had just over 325 thousand manufacturing jobs. Depending on the month, we are around 90 thousand today. It’s almost hard to imagine the region if we took Pittsburgh today and added in the net 235K manufacturing jobs that were lost. It’s even a bit hard to figure where we would be right now if we just added back in the 40 thousand or so manufacturing jobs lost in just the last decade. Yes, that really is the story of late. It’s not all ancient history and 40K manufacturing jobs that were here in 2000 are not here now. Whatever story you want to paint on how Pittsburgh is doing economically, you have to talk about it realizing the story includes continuing hits. Not just the manufacturing loss, but all the USAirways jobs as well for that matter.

Anyway, this is what the long term manufacturing trend looks like. Still scary to look at and it’s just lines on a page. Each job was someone’s career, in most cases their only career, and in many households the only wage earner. Lots of pain in that graph.

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Not your father's workforce

By Christopher Briem, on June 7th, 2011

We’ll crib off Mike explicitly this time, who is himself commenting on Harold’s column over the weekend on women owned businesses. All I can say it reminds me again of a quote I have wound up using a lot. Really, it is one of the most remarkable quotes I have ever found about the Pittsburgh economy, past, present, or future, and use whenever the topic comes up:

(Pittsburgh) will, however, slowly decline unless new industries employing women and those engaged in the production of consumer goods are attracted to the area.

Which is from a report written by a place called the Econometric Institute based in News York City and titled: “Long Range Outlook for the Pittsburgh Industrial Area”, stamped February 12, 1947 and was for the Allegheny Conference and the Pittsburgh Chamber of Commerce.

That date is no typo and as we have looked at this in depth, it really was true for a long long time that female labor force participation in Pittsburgh lagged the nation by a lot. It really took decades after the employment within manufacturing imploded for the region’s labor force to reach some semblance of gender-normalcy when compared to the nation. This change in the regional labor force I still will argue is the single biggest factor in the economic transformation of Pittsburgh over the last 25 years. Put another way, as long as women failed to have similar opportunities here compared to elsewhere, the entire regional economy was doomed to lag the nation. It was as predicted in 1947.

No secret that Harold is often talking about manufacturing. It is indeed the continuing decline in local manufacutring employment that has precipitated the speed at which we have achieved a new paradigm I mentioned recently as well… namely that the regional workforce has in some recent quarters become majority women. Here is some more specific data for employment in Allegheny County which has now been majority women year-round since 2005.

John Kaiser: $1,200 Gold is New Normal

By The Gold Report, on May 16th, 2011

What is good for the U.S. economy is good for gold. John Kaiser, editor of Kaiser Research Online, has proposed a graphic model that relates the value of all above-ground gold stock to global Gross Domestic Product (GDP), thereby explaining why higher real gold prices—even with a recovering American economy—will be the new reality. In this exclusive interview with The Gold Report, he shares his projections about where both gold prices and the U.S. economy could be going in the future.

Companies Mentioned: Barrick Gold Corp. Brett Resources Inc. Equinox Minerals Ltd. Exeter Resource Corp. Geologix Explorations Inc. Northern Gold Mining Inc. Sandspring Resources Ltd.

The Gold Report: Intel Cofounder Andy Grove wrote an article in BusinessWeek bemoaning the fact that U.S. entrepreneurs in both the hightech and cleantech realm have become inefficient in the return of jobs created per investment dollar basis. He said companies hire fewer employees as more work is done by outside contractors, usually in Asia. He suggested this is a problem not only for low-grade production jobs but also robs the U.S. of its innovation edge, hurting the country’s overall economic prospects for the future. Your economic research illustrates this manufacturing decline and shows the value of gold stock values over the last four decades mirroring the U.S. GDP. Why is consolidating manufacturing and research important for U.S. and global growth and how is it linked to the price of gold?

John Kaiser: A lack of physical manufacturing stifles innovation because without access to support facilities, machine shops, test labs and other resources normally associated with a full-scale manufacturing operation, creative people don’t see problems, quickly test solutions and have the ability to bring products to scale in a controlled environment. Cut off from manufacturing operations, development stalls.

john kaiser

The American economy is still the largest in the world with a $14.7 trillion dollar GDP followed now by China at nearly $6 trillion. The problem is that the employment structure of the U.S. economy has, in the last 30 years, shifted very much to service jobs in the healthcare, retail, financial and professional sectors, away from making physical goods, that are increasingly imported. We also have a serious oil addiction, which contributes significantly to the trade deficit as we import oil to keep our cars moving. So what are we actually shipping abroad that allows us to offset all the stuff that we import? The jobs we see in the United States today produce less exportable output. That has not hurt economic growth, but it has been achieved through a drawdown of the wealth accumulated during the last century, a drawdown that accelerated during the last decade when a huge debt expansion party bubbled through the economy. But that party ended in 2008. We have now had two rounds of quantitative easing designed to keep the economy from collapsing. In order for the United States to deal with its long-term structural debts and deficits, it needs to demonstrate that there is something American workers can do that is of value to the rest of the world. The core has to be manufacturing.

TGR: Is your argument that we should ignore the lower cost structure we can achieve overseas, bring assembly jobs back to the U.S. and start manufacturing here? Wouldn’t the cost of goods go up and spur on inflation at a more rapid pace than we’re expecting just because of quantitative easing?

JK: There could be some interim higher costs from bringing manufacturing back to the United States. However, inflation with regard to imported goods due to increasing transportation costs, higher Chinese workspace and emission standards, generally higher wages and the rising value of the Chinese Renminbi is coming anyway. We can’t wait to react until we are stuck paying their higher prices with no domestic alternative because we have lost the manufacturing and R&D infrastructure at home. We need to anticipate this higher overseas cost structure and act now.

TGR: Won’t those jobs just go to another lower-cost Asian country like Vietnam or Thailand?

JK: Those countries have considerably smaller populations and without super-automation they don’t have the capacity to absorb a large-scale influx of manufacturing capacity. If the solution is super-automation, then you are reducing labor costs anyway so why not do it in the U.S. and avoid the political upheaval that could disrupt the production? Two outcomes of the 30-year decline in U.S. manufacturing are that the power of labor unions has diminished, and much of the legacy manufacturing infrastructure has disappeared. To a large degree American legacy production methods were simply shifted overseas where there was an abundance of cheap and willing labor. If manufacturing is to make a comeback in the U.S. it will be in a highly automated form with newly trained employees drawn from the younger generation, not the current boomer generation or their near-retirement parents. If boomers hope to receive their entitlements when they retire, it cannot be paid for by taxing young workers doing little more than fulfilling those entitlement expectations through service jobs.

TGR: Is supply chain and geopolitical security part of what’s driving this consolidation of research and the manufacturing?

JK: Yes. Long term, as China becomes stronger, it will flex its muscles. It’s just refurbished an old Soviet aircraft carrier so that it can park itself in the South China Sea and exert its military presence. If the United States ceases to produce anything, it will become irrelevant and lose influence anywhere in the world.

TGR: Are major companies bringing manufacturing back based on the reasons you just outlined?

JK: Yes, one example is Boeing, which is way over budget and delivery deadline on its new generation of composite materials-based 787 Dreamliner airplanes. Because the company had outsourced construction of every component, including design, the pieces didn’t fit during the assembly process in Seattle. It didn’t work. The company is now looking at changing its outsourcing strategy by developing a centralized industrial park in which its subcontractors will be required to have a physical presence. That way engineers can see first hand if a piece fits.

TGR: Does that mean consolidation of design and manufacturing domestically will be driven by private enterprise operating in their best long-term interest rather than the government mandating it though trade tariffs?

JK: Yes. Protectionism in the old style is not going to fly. Instead, individuals and companies will have to voluntarily adopt total cost accounting. Instead of just looking for a cheap price, consumers will have to consider all the costs associated, including safety standards, environmental factors and sustainability. By adding in the costs that have literally been dumped on somebody else, we do the responsible thing. We have to stop being parasites, hurting others for our own cheap goods. This total cost view will create jobs and make the country stronger in the long run.

From a corporate perspective, the opportunity cost posed by supply chain disruptions needs to be factored into the cost-benefit analysis before they happen, not just ignored and then suffered when natural disasters or political upheavals happen overseas such as recently happened in Japan. If we stop assuming eternally cheap transportation costs, building and operating factories close to destination markets starts to make sense. It’s also time to ditch the narrow-minded self-interest of the libertarian school and borrow a page from Henry Ford’s book of enlightened self-interest: if you want consumers to buy your product, they need to pay with money earned through productive jobs, not entitlement spending.

TGR: While we’re talking about consolidation and the global shift, please comment on the Barrick Gold Corp. (TSX:ABX; NYSE:ABX)/Equinox Minerals Ltd. (TSX:EQN; ASX:EQN) deal. You predicted gold in the thousands last year. Why do you think Barrick Gold purchased Equinox Minerals, a copper play in Chile, when gold is at an all-time high right now?

JK: First, gold is not at an all-time high in inflation-adjusted terms, which would be about $2,300 using the $850 peak in 1980 as a base. It is only two-thirds of the way to an all-time high. But if we use $400 where gold settled in 1980 as a base, the inflation-adjusted price is about $1,024. That means today’s gold price of $1,500 is about 50% higher than in 1980 in real price terms. But rather than look at the gold price, I look at the value of the above-ground gold stock. About 3.2 billion ounces (Boz.) existed in 1980; today that number is about 5.8 Boz. It is remarkable that during a 30-year period the mining industry nearly doubled a gold stock, which had taken several thousand years to build. This was possible because between 1970 and 1980 gold underwent a tenfold price increase. That equaled a 500% real increase for a mining industry locked in a $35/oz. mindset. Once gold was released from its monetary prison, it established a new relationship to the value of the global economy expressed in U.S. dollars, which I have graphed.

john kaiser

Models are based on each country’s GDP converted into U.S. dollars. While a 50% devaluation of the U.S. dollar should not change the nominal U.S. GDP, the U.S. dollar GDP of all other countries would rise, boosting global U.S. dollar GDP sharply to $110 trillion without any real growth. That would translate into a $2,100/oz. gold price if the gold stock stays valued at 10% of global GDP. Of course, the cost of everything would increase correspondingly and gold companies would be no better off than they are now at $1,500 gold. The model also accounts for the inflation of the gold stock through mine supply. A higher real price will boost gold production, which CPM Group projects as growing from 83 Moz. in 2011 to 103 Moz. by 2016.

I took the above-ground stock of gold that existed in each year and multiplied it by the average price of gold during that year to get the value of all the gold that existed in each year. Then I divided it by the nominal GDP of the world for each corresponding year. That produces an interesting chart. It shows gold going from about 3% of GDP in the 1970s to a peak of 20% during the 1980 bubble and then crashing all the way back down to 4% in 2002 at the bottom of the gold market. Now it is 10%, which is about halfway to what you might regard as a bubble peak. I think gold will stabilize at these levels and go up as GDP grows.

The International Monetary Fund is predicting that our $62 trillion GDP from last year will be almost $90 trillion globally by 2016. So, if you take 10% as the norm, gold should be stable within a $1,400/oz. to $1,700/oz. range over the next six years. That’s a sustainable price assuming the world is growing. Growth would also result in increased copper demand. Barrick is diversifying its revenue base and treating both gold and copper as commodities. Copper, because it is mined to serve as a means to an end rather than as an end in itself as is the case with gold, does not have the arbitrary price volatility of gold. If suddenly the world decided it didn’t need the gold anymore and wanted to convert it into some other form of asset, it would be worth a lot less. Because copper is useful for construction, there is a limit as to how low it can go. Barrick sent a signal that it thinks the global economy is going to grow, that we are not dealing with either a looming depression or hyperinflation. I welcome that because it means gold and copper will have a strong future for the next five years.

TGR: Do you foresee more mergers and acquisitions in precious metals? Is this the start of a trend?

JK: Yes. As companies focus on advancing projects, it will take large capital investment. It will be difficult for a stand-alone project to raise $500M+ without being absorbed by a bigger company that already has production in place and is generating cashflow. This is an opportunity for large, liquid companies to acquire these assets without paying a big premium, particularly if it uses its paper as currency. It is a one plus one equals three situation because as the acquiring company diversifies its revenue base, its catastrophe risk declines. As the market gets more comfortable with gold at current levels, we will see mergers and acquisitions step up and more money coming into the market.

TGR: So, you see economic growth as price drivers for both gold and copper?

JK: In the case of gold, yes. In the case of copper, the question is whether $4 copper is the new reality on which we can base mine development decisions, given a low inflation scenario. The key thing that has happened in the last decade is that China has become a significant economic force. It has now displaced Japan as the second-largest economy with a billion-plus population base and relatively low per-capita GDP. It could grow substantially and eventually become larger than the U.S. economy. But, China is still an unusual political entity; it is a hybrid communist-capitalist country. As they get stronger, we have no idea how they will behave on the global stage. Therefore, people are shifting capital into gold as part of their long-term security plans. As GDP grows, it will probably grow faster than the ability to bring new gold supply on stream. Therefore, gold will rise in price as it tracks the strength of the global economy.

TGR: If you’re expecting the price of gold to track nominal GDP, which is growing 2% to 4%, won’t you see money coming out of gold and going into equities that would probably represent a higher potential return?

JK: All the gold in the world is about 5.3 Boz., worth about $8 trillion. That’s really a fraction of the estimated net worth of all other assets, which is about $130 trillion. Most gold is held as a long-term asset. So even if the crazy gold bugs start selling to buy stocks, they are a small minority and won’t make a huge difference. I believe the value of gold stock as 10% of GDP is a reasonable level. Make it a lot higher and gold owners will look to convert it into other assets such as land, buildings, resources and dividend- or interest-yielding instruments capable of generating a cash flow as opposed to a capital gain. What would the new owner’s reason be for buying? The only return generated by gold is psychological stress relief. However, if gold prices surge to 20% of GDP as it did in 1980, it will be because of an unstable global situation. Under such conditions, gold ownership is not likely to offer much stress relief, especially if government confiscation or a breakdown of law and order become risks. At 20% of GDP, the value of the gold stock would imply a price of about $2,400 in real terms (as opposed to a price rise generated by excessive inflation or a major devaluation of the U.S. dollar against other currencies). In 1980, when gold was 20% of GDP, some thought the United States had reached the end of the line. But the United States survived that crisis and went on to win the Cold War, unleash globalization and accelerate time through the Internet communications revolution. Short of a calamitous collapse in China, I see the center of gravity for global economic and military power gradually shifting away from the United States during the coming decades. On the other hand, I do not see the value of the gold stock dropping back to 5% of GDP because this would require a major decrease in our uncertainty about the future global order.

TGR: What does this mean for silver? Both gold and silver had a setback recently.

JK: Silver has been the worst performing metal for decades. What it’s doing now is a bit of a catch up. Although most of the above-ground silver stock of 46 Boz. is fabricated into some useful form, unlike gold, silver is gaining popularity, especially in emerging economies. The above-ground silver stock value went from 1.5% of GDP in 1970 to a peak of 6% in 1980. But by 2002 the silver stock was worth only 0.5% of GDP. Right now it’s between 2% and 3%. I believe silver can parallel gold’s role as a hedge against the uncertainty associated with the long-term relative decline of the United States and the gradual disappearance of the U.S. dollar as the world’s reserve currency. If we assume the silver stock will establish a value as 3% of global GDP, the price will base out in the $30–$40 range this year, which will grow to $47–$57 by 2016. If it goes to $100/oz., that would indicate a bubble reflecting the inflation-adjusted equivalent of the $50 peak in 1980. Because the recent price growth looks exponential, the markets have fought back and a bear attack is pushing silver back down. But I believe $30–$50/oz. will be the new long-term reality, which opens up some good buying opportunities among silver companies in the next couple of months.

TGR: Since the pullback is happening right now and it has been pretty dramatic, wouldn’t the buying opportunity be now? What will be different in two months?

JK: I’m not a big fan of catching falling knives and anvils. I like to see them bounce around first so I know they’re not going to hurt me. Especially this time of year, it might be best to see where silver and gold stabilize.

TGR: What do all these new economic drivers mean for gold, copper and silver mining companies? And what companies could capitalize on these changes?

JK: Well, the pessimism embedded in the market right now about the U.S. economy and, ultimately, the global economy that still very much depends on the U.S. economy, has discouraged the market from taking current metal prices seriously. If you plug in $1,500/oz. gold and $4/oz. copper into the discounted cash-flow models for these development projects, you get some very sexy numbers compared to what the stocks are trading at. For example, take Geologix Explorations Inc. (TSX:GIX). It has the Tepal Project, a copper/gold play. It’s not super high grade or very large. But, right now the stock’s trading below $0.50. Conservative numbers like $2.75/lb. copper and $1,100/oz. gold result in a value of about $1.10 a share, which is not very exciting. But plug in current prices, $4/lb. copper and $1,500/oz. gold, and the target blossoms into the $3/lb.–$4/lb. range.

We see this across the board, an unwillingness to plug current metal prices into the valuations because of an assumption that we’re going to see copper back below $2/lb. or gold back to $1,000/oz. And, yes, if we end up in a global depression we will certainly see the metal prices go back down. But I see the global economy trending upward, causing gold and copper to stay strong, thereby leading to an inflection point when the market realizes this pessimistic attitude is all wrong. Then the market will take these prices seriously and put capital into mining projects to mobilize new metal supplies. The problem with mine development is it takes three to five years to realize. That is why we need to start going after these huge profit margins now instead of perpetually waiting for signs of an enduring recovery. The irony of the inflation we are seeing in raw material prices today, which threaten to destabilize emerging market economies, is that it is due to the reluctance of capital markets to take the IMF GDP growth projections seriously and deploy capital to mobilize new mine supply.

TGR: What companies are making those investments today?

JK: Sandspring Resources Ltd. (TSX.V:SSP) is an example. It started off as an alluvial gold operation in Guyana. The company ended up going public and raising capital to focus on the bedrock potential, thereby developing a large gold resource with a minor copper credit. Sandspring just completed a preliminary economic assessment using current pricing that suggests the project is worth about $900M. Yet the market valuation is about $300M. That gives you three to five times upside potential if there are no glitches in the pre-feasibility study and current metal prices get nailed to the wall.

Exeter Resource Corp. (TSX:XRC; NYSE.A:XRA; Fkft:EXB) is another example. The company discovered the Caspiche deposit in Chile. It has a large copper resource. It also has a low-grade gold-oxide resource on top. The copper resource is too big for Exeter to develop on its own and in view of the capital cost escalation being suffered by similar large deposits bought out before the 2008 crash and the skepticism that $3–$4 copper is the new reality, Exeter will have a hard time attracting a buyout by a major in the near term. So, to create value while it bides time, the company is now focusing on developing a gold-oxide leaching operation to take advantage of the 1.4 Moz. resource sitting on top of this system.

TGR: Any other companies that could take advantage of the new pricing reality either in the gold, the copper or the silver area?

JK: Grade is very important in the gold sector. Last year Osisko (TSX:OSK) took over Brett Resources Inc. (TSX.V:BBR) and its Hammond Reef Deposit in Ontario, which is just under 1 g/t and about 7 Moz., at about $4. Now that the market is getting more comfortable with the idea of gold north of $1,200/oz., other similar low-grade projects are looking attractive.

Northern Gold Mining Inc. (TSX.V:NGM) is an example. The company’s 700 Koz. Garrcon Project wasn’t very interesting when gold was below $1,000/oz. But, at current prices, the company has an incentive to do step out drilling and lower the cutoff grade in an effort to boost that resource to a 2 to 4 Moz. Open pit mineable. This $40M market cap company could undergo a fivefold increase if Northern Gold triples the resource and delivers a positive prefeasibility study.

TGR: Are you saying that whether we are in a depression as some believe or a recovery as you have outlined, we’ve already seen the floor of $1,200/oz. for gold and these companies are a low-risk return investment?

JK: Not exactly. In the scenario where gold rises because the American economy is in a death spiral, the solution is to pursue a hyperinflation strategy that results in costs rising in conjunction with the price of gold. So, that is of no benefit to the companies. If the alternative is to just curl up in a fetal position and suck one’s thumb and prepare for the end, that will result in gold prices going down. The best alternative for resource juniors is if the world avoids both a deflation-linked depression and hyperinflation scenarios, the American economy gets back on track with a revival of manufacturing on U.S. soil and the global economy continues to grow. That will be good for raw material demand and gold and silver prices.

TGR: Thanks, John. Enlightening as always.

John Kaiser, a mining analyst with over 25 years’ experience, is editor of Kaiser Research Online. He specializes in high-risk speculative Canadian securities and the resource sector is the primary focus for an investment approach he developed that combines his “bottom-fishing strategy” with his “rational speculation model.” Kaiser began work in January 1983 as a research assistant with Continental Carlisle Douglas, a Vancouver brokerage firm that specialized in Vancouver Stock Exchange listed securities. In 1989 he moved to Pacific International Securities Inc., where he was research director until April 1994 when he moved to the United States with his family. He launched the Kaiser Bottom-Fishing Report (now Kaiser Research Online) as an independent publication in October 1994 and developed it into an online commentary and information portal. He has written extensively about the junior resource sector, is frequently quoted by the media, and is a regular speaker at investment conferences. Since 2008 he has developed a focus on security of supply issues and how they relate to critical metals such as rare earths.

Other Alpha Sources

By Claus Vistesen, on February 22nd, 2011

I am not sure I buy the story that if China allowed its currency to appreciate all the world’s problems would be brushed away in one clean stroke. But I concur that the appreciation of China’s currency and indeed that of many of the big emerging markets primarily against the USD would certainly help. This is especially the case now that China (and the rest of the EM edifice) are sitting on a mounting inflation problem.

Dave Altig from the Atlanta Fed delivers a nice argument;

(…) if printing money does not buy you control over real stuff, it is very definitely a factor in controlling the nominal exchange rate—a measure of the value in trade of currency for currency. And there, I believe, is the crux of the problem. To keep the nominal exchange rate from rising, the People’s Bank of China in effect prints yuan and buys dollars. Though this has limited impact on any real fundamentals, it is the source material for inflation. In fact, if a monetarist heart beats within you, the picture of the recent Chinese inflation experience will surely warm it.

I have long believed that one part of the problem here is the unique focus on China where the real focus should be on much broader based global currency alignment in which a basket of emerging market currencies appreciate against the G3 as a whole. This would then serve to rebalance global aggregate demand most efficiently.

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As an economist there are many things to feel negative about at the moment and I would honestly admit that also I must sometimes struggle not to descend into the bottomless pit of eternal doom and gloom. In that vein, I was refreshed by the Economist’s recent look at 3D printing which basically covers a whole new and growing area of manufacturing (of everything imaginable) in 3D much the same way as printing a piece of paper.

THE industrial revolution of the late 18th century made possible the mass production of goods, thereby creating economies of scale which changed the economy—and society—in ways that nobody could have imagined at the time. Now a new manufacturing technology has emerged which does the opposite. Three-dimensional printing makes it as cheap to create single items as it is to produce thousands and thus undermines economies of scale. It may have as profound an impact on the world as the coming of the factory did.

It works like this. First you call up a blueprint on your computer screen and tinker with its shape and colour where necessary. Then you press print. A machine nearby whirrs into life and builds up the object gradually, either by depositing material from a nozzle, or by selectively solidifying a thin layer of plastic or metal dust using tiny drops of glue or a tightly focused beam. Products are thus built up by progressively adding material, one layer at a time: hence the technology’s other name, additive manufacturing. Eventually the object in question—a spare part for your car, a lampshade, a violin—pops out. The beauty of the technology is that it does not need to happen in a factory. Small items can be made by a machine like a desktop printer, in the corner of an office, a shop or even a house; big items—bicycle frames, panels for cars, aircraft parts—need a larger machine, and a bit more space.

Needless to say that this holds the potential to completely revamp manufacturing processes and re-define the nature of scale economies. However, apart from the potential to re-navigate the face of the already established manufacturing industry two things stand out to me.

Firstly, the notion of 3D printing brings the world of science fiction closer by leaps and bounds. Forget about printing a cup at home if you break one in the kitchen. Think 3D printing in conjunction with the emerging technology of manufacturing organs and other organic material. Then think about the promise that much less raw material need to be used and you are only a small step away from Picard pushing a button in Star Trek and invoking a meal or of course the irresistible scene in the Fifth Element in which an obviously hungry Leeloo creates a nice juicy chicken on a split second using, presumably, a small capsule containing the condensed raw material to create such a meal. Clearly, such things would easily be possible in a 3D printing setting and indeed, once transferred into a setting of “organic material”, the possibilities are mind blowing.

Secondly, I am in awe about the potential this holds for home and small scale manufacturing in connection with an open source environment. Obviously as the Economist points out, the flip side to this is that companies will need to come up with new ways to protect source codes (or blue prints) to their products since this would be the main source of their intellectual property. Yet, the heretic in me marvels on the potential of this coupled with some nifty reverse engineering. Imagine a complex product such as a Porsche 911. What if you could reverse engineer it, supply the material, and then feed the blue print into your generic manufacturing scale printer and presto, you would be the maker of luxury German (or Danish) sports cars. Clearly, how companies serve to protect themselves from exactly this kind of abuse is crucial to the success of 3D printing. But then again, one could easily imagine companies selling blueprints online to simpler products which consumers could then produce at home.

In short, if you want a positive view of the future look no further.

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Finally and perhaps because it spoke kindly to be prejudices in relation to the ongoing climate change debate, I really liked Leon Neyfakh’s review of a new book by Colby College historian of science James Rodger called “Fixing the Sky: The Checkered History of Weather and Climate Control,”;

One can’t help but feel a little embarrassed on behalf of the species, to have been involved in all this fuss over something as trivial as the weather. Is the human race not mighty? How are we still allowing ourselves, in the year 2011, to be reduced to such indignities by a bunch of soggy clouds?

It is not for lack of trying. It’s just that over the last 200 years, the clouds have proven an improbably resilient adversary, and the weather in general has resisted numerous well-funded — and often quite imaginative — attempts at manipulation by meteorologists, physicists, and assorted hobbyists. Some have tried to make it rain, while others have tried to make it stop. Balloons full of explosives have been sent into the sky, and large quantities of electrically charged sand have been dropped from airplanes. One enduring scheme is to disrupt and weaken hurricanes by spreading oil on the surface of the ocean. Another is to drive away rain by shooting clouds with silver iodide or dry ice, a practice that was famously implemented at the 2008 Olympics in Beijing and is frequently employed by farmers throughout the United States.

And of course, the last paragraph strikes a special chord with me;

The good news for practitioners of weather control is that amid all this complexity, they can convince themselves and others that they deserve credit for weather patterns they have probably had no role whatsoever in conjuring. The bad news for anyone who’d like to prevent the next 2-foot snow dump — or the next 2 degrees of global warming — is that there’s just no way to know. As Fleming’s account of the last 200 years suggests, it may be possible to achieve a certain amount by intervention. But it’s a long way from anything you could call control. Those who insist on continuing to shake their fists at the sky should make sure they have some warm gloves.

Makes sense to me.

Retail Sales Likely Skyrocketing into February

By Eldon Mast, on February 9th, 2011

According to the ICSC-Goldman’s retail sales report on Tuesday, same-store sales skyrocketed in the February 5 week, up 2.2 percent.

It was the largest weekly gain since the Easter surge of last March.

The year-on-year the rate jumped nearly one full percentage point to plus 2.5 percent.

The Redbook report, also released on Tuesday, was right in line with a measure that showed a 2.7 percent year-on-year same-store sales growth in the February 5 week.

Additionally Redbook offers a month-to-month comparison which registered a blistering 1.7 percent gain. Keep in mind that annualized that would point to a 20.4 percent retail gain in one year!

Early next week the government will post the January retail sales report amid most predicting a solid gain.

The economy accelerated at the end of 2010 as consumer spending climbed by the most in more than four years. Gross domestic product grew at a 3.2 percent annual rate, Commerce Department figures showed on Jan. 28.

And remember last week the ISM Manufacturing Index pointed to an overall economy in the month of January growing at a GDP annualized rate of 6.4 percent.